Confessions of an Alleged Market Timer

Why one manager says his large cash positions don't represent an attempt to time the market

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During the past year, mutual fund manager Stephen Shipman has regularly transformed his Quaker Small-Cap Tactical Allocation Fund. At one point in 2008, he had virtually the entire portfolio in cash, but at times this year he has been around 85 percent invested in the stock market.

[See 4 Small Caps With Room to Run.]

Traditionally, a swing that large in cash allocations has been considered a hallmark of market timing, a risky strategic gambit that involves weaving into the market during strong periods for stocks and pulling out in advance of perceived slowdowns. While market timing is generally taboo in the mutual fund world, a recent Wall Street Journal article says it's on the rise as managers look to "lure back investors still wary of stocks." In the story, Shipman's fund is featured as one of the banner examples of the renewed interest in market timing.

In a broad sense, the suggestion that market timing is in vogue cuts to the core of a hotly disputed question in the fund community: When is it appropriate to stash large portions of a portfolio in cash? In 2008, a number of defensive managers beefed up their cash holdings, but many have since begun moving back into the market. As this return to nearly fully invested portfolios plays out, managers who remain heavily positioned in cash are increasingly drawing scrutiny.

[See Should You Deep-Six Your Mutual Fund?]

But for Shipman, large cash positions are nothing new. While the Quaker Small-Cap Tactical Allocation Fund was launched only last year, Shipman has been running Century Management's Small Cap Absolute Return Fund since 2000, and he has kept this institutional fund's cash stake consistently high over the years.

In an interview with U.S. News, Shipman said that the recent fluctuations in his Quaker portfolio, which has returned 12.3 percent year-to-date, stem from the volatility of small-cap growth stocks and from his strict buying and selling discipline rather than from an attempt to look into a crystal ball. And as the cash debate rages on, Shipman explained why he thinks managers can move in and out of the market without trying to time it. Excerpts:

Why does the term "market timing" have such a bad reputation?

I can't represent the rest of the community, but I think that probably the average professional portfolio manager thinks that market timing assumes that somehow you know and can predict the future of all price directions. Maybe there are people out there that can do that; I haven't met very many. I think that you can inform yourself as to what factors may influence price direction, but to think that you can predict all of those many years out, especially with politicians with their finger on one quarter of the economy, is probably ridiculous.

Why have you kept substantial portions of your portfolio in cash , if not to time the market?

Let me make one thing really clear: The antecedent institutional program that I have run for this Quaker small-cap fund is called Small Cap Absolute Return. I've been running it for 9½ years; I started April 1, 2000, and it's been primarily high-net worth individuals. From that time period of April 1, 2000, till this past quarter, the average invested position has been about 53 percent and the average cash position about 47 percent. So one thing that I'd make very, very clear is that the cash holdings are not a top-down decision. It's not a market-timing decision; it's not a market-directed, market-influenced decision. It's all the result of the organic investment process that I've designed and executed over the last almost 10 years.

In the past year, how much have your cash positions fluctuated?

We've been in an extremely unusual year. I would say you have to go back to 1907 to find the antecedent. But answering your question, there were times—and by times I mean literally days or so—when last October and November I was virtually 100 percent cash. I actually had equity positions in place of 20, 25 percent, maybe 30 percent, but I actually shorted against those positions in exercise of my discipline. So that's as high in cash as I've been—let's call it 95, 100 percent for very short periods of time. Again, it may have been only for two or three days. . . . I think the highest invested position I've had this year was sometime during the summer months when I was probably somewhere in the 85 to 86 percent range.

Isn't all that variation an indicator that the markets look most attractive to you at certain times?

No, it isn't, and I've got to be really clear on this. I think I have developed a unique strategy that is applicable in particular to small-cap growth stocks. And in addition to that, what I've really done is adapted the sort of value [concept] of margins of safety to very risky, high-growth companies and stocks. To apply that particular margin of safety, I need to be very, very disciplined on three different levels: One, on the price of the security I want to own; two, on the balance sheet characteristics; and three, and this is really important for my particular space, I need to have a technical characteristic in place that requires the stock to sell above the 150-day moving average. Those three things need to be fulfilled for me to want to own a stock. Often those three work independent of the marketplace . . . and for instance last October when . . . I had very limited [stock] exposure, it wasn't because I was making a market judgment on what had happened in September or what might happen in November, but simply because we couldn't find the names to populate the portfolio.

Why do you focus on a segment of the market where you can't find enough names to consistently fill the portfolio?

[Because I can] still get great returns. . . . When you buy these fast-growing stocks cheap enough and you have confidence in the pricing of the absolutes, in essence you're buying only those stocks that are going to act like coiled springs and have a great opportunity for price appreciation almost immediately. And if I do that often enough—it's kind of like if I'm Manny Ramirez or if I'm Derek Jeter, two guys who have a great reputation for understanding the strike zone—then all I have to do really is wait for those strikes. And the difference is I can swing as often as I want.